Is Dubai's Default a Black Swan Event?

The term “Black Swan” is used far too often in today’s discussions about the financial markets and it pertains to unforeseen events that cause havoc on the economy or the markets themselves. Last year was called a “Black Swan” event even though the warning signs were there for at least a year, some say since 2006. In today’s discussion the news coming out of Dubai is being hailed as another Black Swan event as they are talking about delaying payment on some of their debt on December 14.

The events in Dubai are the furthest thing from a Black Swan event as we have all known about this problem for the better part of 6 months or more. The country is in poor financial shape and is, basically, insolvent without a bailout from its neighbor Abu Dhabi. The rulers of the two nations are related. I would be willing to bet that the bailout will come in some fashion, but only after an example is made of the smaller nation, but is this a Black Swan event? What is a more relevant question is will a technical default on Dubai’s debt be a trigger for something bigger?

I do not believe that the Dubai situation is a Black Swan event as it was a known situation for some time and those who lent the country money knew they were way over leveraged and lent that money at their own risk. Whether or not this default, if it actually happens, will lead to other events, a domino effect if you will, remains to be seen. Since the sub-prime situation led to a domino effect in the mortgage market, it is safe to assume there will be some fallout from a sovereign default somewhere along the way. Considering Mexico was downgraded to BBB and Vietnam raised interest rates and devalued its Dong by 5%, there are definitely tremblings in the FX markets that cannot be ignored.

The effects of these issues are unknown to me at this time because I do not know how China will respond, although I have my speculations, nor do I know what exposure US or European banks have to the Middle East at this stage of the game. I am willing to bet their exposure, especially JP Morgan (NYSE:JPM), BoA (NYSE:BAC) and Citi (NYSE:C), is much higher than we all think since interest rates in that area of the world are much higher than the “norm” in the US and Western Europe. However, the real Black Swan events that I think are being ignored are the ones in Eastern Europe where currency devaluation and real sovereign default is actually happening and has been happening for some time now. Not that you ever hear about that from the media, but read about it sometimes in European blogs or news outlets - and it is disturbing.

Basically, I believe the greenback will have the stay of execution I have been expecting for some time now and it should rally nicely on this possible default news. In reality, a Dubai default means very little to the US other than a sovereign nation defaulting, but it will trigger a flight to quality. This means if the dollar equity trade is intact, the market could be in real trouble. Further pressure for the greenback is coming from Japan who said it was concerned over the Yen’s strength Wednesday night in a Bloomberg story. This is an issue I wrote about a day ago as well, but essentially the Yen is up about 8% against the USD, which is an issue for the Japanese since they export more goods than they import. A strong Yen is not good for them as it means their products will be more expensive in the US and China; expect to see Japan intervene in the FX markets to strengthen the USD/JPY pair.

This puts the US at odds with its trading partners because while we talk like we want a strong currency, we do not. A weak currency means we make our products cheaper overseas, narrow our trade deficit and essentially boost our GDP in a very phony way. As an aside, it also makes corporate profits look fantastic if they generate any overseas business. A weak dollar means they can sell the same amount, or less in fact, and when those earnings are turned over to US dollars it looks like sales increased when they did not: Houdini earnings! We will have to see whose will is stronger, the will of investors who are about to flee to the USD for protection, which will surely drive up the USD, or Helicopter Ben and our Congress, hell bent on devaluing our currency to pay for their crazy social engineering. This will make it look like they are leading us to recovery when they are really leading us to a Zimbabwean fate.